Don't Bet on Lower Housing Prices in 2011

If you were thinking of buying or selling a home and looked at the latest price data, you’d probably agree with what many experts are saying — prices will continue to drop in 2011. Although average house prices more than doubled from January 2000 to July 2006, they had plunged 33 percent from their peak by April 2009. Because prices are still 39 percent higher than at the start of century, some analysts warn that they have further to fall. After briefly stabilizing and rebounding a bit, the latest data suggests that prices are falling once again. The S&P/Case-Shiller Index is down three months in a row, and for the first time in nine months, is lower on a year-over-year basis.

Despite the deteriorating trend, don’t bet on housing prices to fall this year. The Case-Shiller Index has a two-month lag and the most recent report is for the month of October. Since that time, we’ve had a power-shifting midterm election, an extension of the Bush-era tax cuts, an arms treaty with Russia, and a possible trade agreement with South Korea. While there is good reason to assume that housing prices could fall further, there are also encouraging signs that prices might strengthen instead because of a growing economy.

On the negative side, delinquencies, foreclosures and inventories are still much too high. Furthermore, mortgage rates have jumped. This is particularly worrying because the rise in rates comes in spite of the Federal Reserve’s $600 billion effort to drive interest rates down. The Fed is using the money to purchase long-term Treasury bonds. In theory, the Fed’s effort should increase demand for Treasury bonds, raising their prices and reducing their yields. Because mortgage rates are tied to Treasury rates, they too should go lower. So far, however, things are not going according to plan.

Yet the rise in interest rates could actually be a sign that investors are growing more optimistic about the economy’s prospects. This means housing prices could strengthen even if interest rates go marginally higher — especially if potential buyers who have been sitting on the fence think they better buy now before rates rise further. The Fed has a dual mandate: price stability and full employment. Right now the Fed is focusing its efforts on the latter. This is good because in the current environment employment is affecting housing prices more than interest rates are. The Fed’s real intention is to prompt banks to lend more money to businesses. Once businesses invest those funds, jobs should follow.

There is some evidence that the Fed’s plan is working. Business loans held by U.S. banks had been falling ever since the financial crisis began in 2008. According to the St. Louis Fed, in October 2008, large U.S. banks had more than $800 billion of commercial and industrial loans on their books. Two years later, the balance had plunged to just $600 billion. However, business loans during the past two months have inched up to $612 billion. The gain isn’t enough to get anyone overly excited, but at least it is a move in the right direction.

In addition, there is encouraging news on the jobs front. Initial jobless claims fell to 388,000 for the week ending Dec. 25, down from 422,000 in the prior week. The improvement may simply be due to temporary hiring during the holiday season, yet it marks the first time since July 2008 that initial jobless claims dipped below the critical 400,000 level.

Finally, the National Association of Realtors said its Pending Home Sales Index jumped 3.5 percent from October to November. This index, which anticipates closings by a month or two, has been improving over the past five months, providing hope that buying activity is picking up.